Page 18 - Business Insights Technology Industry

RESEARCH & DEVELOPMENT
TAX CREDITS

T he Credit for Increasing Research activities and also the wages of employees who After calculating the allowable R&D credit for
Activities, or as it’s more commonly are directly supervising and directly supporting
the tax year, the business has multiple options
known, the Research and Development the research activities. Wage expense is only as to how to apply it. Previously, the R&D
(R&D) credit, is a federal tax credit designed eligible to the extent the individual spent his or her credit was treated solely as a component of the
to benefit businesses who conduct certain time actually performing the activities. However, general business credit meaning it could only be
qualifying R&D activities. With the passage if an employee spends substantially all of his or used to reduce the business’ tax liability. If the
of the Protecting Americans from Tax Hikes her time conducting qualified research, defined as business had no tax liability in the credit year
(PATH) Act of 2015, the R&D credit has now 80% or more, then the entire amount of wages for either due to an operating loss or the utilization
been made permanent for all tax years beginning that employee will be deemed eligible. Contract of another credit, any unused R&D credit could
on or after January 1, 2015. Prior to that, it was expenses include amounts paid to independent be carried back one year and carried forward
renewed on an annual basis as part of the annual contractors and outside organizations for the twenty years. This may seem fine, but many new
tax extenders package. Now that the R&D credit performance of qualified research. The IRS puts small businesses do not see net income for many
is permanent, businesses can plan and conduct a 65% limit on these expenses although there are years after they begin operations and therefore it
research activities confidently and know for 100% and 75% exceptions for certain qualified could be years before they see the benefit of the
certain that their activities will qualify them for research organizations. tax credit. To remedy this, lawmakers added two
a credit at tax-time. new ways that the R&D credit could be utilized
Once a business has calculated its qualified effective for tax years beginning January 1,
In order to determine which activities qualify research expenses, the next step is to calculate 2016 or after: against the business’ Alternative
for the R&D credit, the IRS adopts a four-part the credit. There are two different methods for Minimum Tax (“AMT”), or against the
test. First, the activity must be undertaken for calculating the R&D credit: the regular method employer portion of FICA payroll taxes. These
the purpose of developing a new or improved and the alternative simplified method. The two alternative applications are only available
product and/or business component. If regular method requires more information to to eligible businesses. To qualify for the AMT
improving a product or business component, calculate, but generally yields a higher credit offset application, a business must have less
the improvement must increase performance, amount than the alternative simplified method. In than $50 million in average gross receipts for the
quality, reliability, etc.; a purely cosmetic change order to calculate the R&D credit using the regular preceding three years. To qualify for the payroll
would not constitute an improvement. Second, method, a business will need to know its amount tax application, a business must have under $5
the activity must be undertaken for the purpose of qualified research expenses in the current year, million in gross receipts during the current year
of discovering new information intended to the average amount of annual gross receipts for and they must not have had any gross receipts
eliminate uncertainty relating to the method the previous five-year period, and the number of before the five-year period preceding the current
of development or plausibility of the product years in which the business had qualifying R&D year. Both of these methods offer the potential
design. Third, the activity must be technological expenses prior to the current year, if any. For for businesses to utilize the benefits of the R&D
in nature and fundamentally rely on the principles startup companies, putting together these records credit much sooner than ever before.
of physical or biological sciences, engineering, is relatively simple. However, for companies
or computer sciences. Fourth, the activity must that have been in business for many years, it Many different types of businesses, even if they
involve a process of experimentation during can be difficult and cost-ineffective to determine are not in a traditional research and development
which the business creates and tests hypotheses, exactly what year the first R&D expenses were industry, can benefit from the R&D credit. A
evaluates alternatives, and ultimately draws incurred. Companies in this situation would be plethora of activities qualify and it is definitely
conclusions based on results. better off using the alternative simplified method worth a review to see if one or more of the
calculation. Under the alternative simplified activities that your business is performing may be
If an activity meets all four of these tests, then method, the business needs only to know its among them. It is also highly advisable to consult
certain expenses related to the activity may qualified research expenses in the current year a tax advisor as it is possible that you can amend
qualify for the R&D credit. Eligible expenses and the previous three years. In general, the previous years’ tax returns to claim additional
include payments for qualified services, supplies, alternative simplified method yields a lesser benefits. They will also be able to advise you on
and personal property used in the conduct of credit than the regular method, but for many the nuances of the R&D credit as certain areas
qualified research, and certain contract research companies this is a worthwhile tradeoff as it does can become fairly complicated.
expenses. Payments for qualified services include not require the review of financial records dating
wages paid to employees conducting the research back to the business’ inception.

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